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In my last article, I covered how to predict the earnings of a company and today I am going to write about how to do industry analysis.

The Need for Industry Analysis

Industry analysis is an essential responsibility for an equity research analyst.

As an equity research analyst, you need to analyze a particular industry, see its past trends, demand-supply mechanics, and future outlook.

The industry analysis report sheds light on the economic health of the company, underlining the understanding of whether it will be beneficial for the stakeholders to invest in such a company and offering recommendations and/or corrective actions to take in case of any untoward developments in the company.

As an equity research analyst, you might work on industries like Oil and Gas, Metal, Information Technology, Automobile, Financial Services, Infrastructure, Pharmaceuticals, and Consumer durables.

In some companies, there is a dedicated industry analyst who will work in the assigned industry and provide the analysis.

However, as an analyst, you should be aware of industry dynamics and hence, it is important to know how to do industry analysis.

How to do Industry Analysis?

Industry analysis is a complicated and time-consuming process.

If any of the dimensions are missed, the whole analysis becomes faulty.

Therefore, in this section, I have highlighted all the necessary steps telling you how to do industry analysis.

Use these steps and apply them in your analysis.

What are the steps? Here you go:

1. Review available reports

Read all the available but relevant industry reports and statistics to see whether it makes sense to dig deeper.

Some of the reports you will find already contain in-depth information that the need for new industry analysis is eliminated.

However, it is unwise to depend on existing analysis reports as the market is always volatile and industry factors change constantly.

Therefore, pick up a current report and envisage its relevancy in the current market.

2. Approach the correct industry

An industry has sub-parts.

For example, if you look at the chemical industry, you will find sub-industries like Fertilizers, Pesticides, Paints and Varnishes, Organic chemicals.

Therefore, it is important to focus on the relevant industry.

Without this, it will be impossible to draw an accurate industry analysis report.

So, take up an industry and find out the sub-industries. Select the one which suits the company's purpose.

Moreover, it is worthwhile to look at the different market segments in a particular industry.

3. Demand & supply scenario

As any economist will know, demand and supply are the primary factors governing any market.

Hence, it becomes relevant to look into the demand-supply scenario for a particular product or industry by studying its past trends and forecasting future outlook.

You can do a comparative analysis with other companies competing, in the same manner, to find out the economic health of the company under consideration.

Future demand and supply forecasting help investors understand the viability of future investments in terms of profits and losses.

4. Competitive scenario

This is the most important step in any industry analysis.

In this, you need to study the competitive advantage scenario using Porter's Five Forces Model.

The model acts as the framework for industry analysis.

Michael Porter, a famous strategist, and author, first came up with this model.

In this model, five parameters are analyzed to see the competitive landscape.

They are:

1. Barriers to Entry

2. Supplier Power

3. Threat of Substitutes

4. Buyer Power

5. Degree of Rivalry

Porter's five forces model and competitive forces are extensively used while analyzing any industry.

5. Recent developments

Any industry analysis report isn't just about studying a particular industry on a micro-level.

The analyst needs to incorporate influencing factors at the macro-level.

These macro-level factors include recent industrial developments, innovation in your industry analysis report, sector valuations and global comparative valuation.

6. Focus on industry dynamics

The industry analysis should be specific to a particular industry and thus, it is important to focus and understand the industry dynamics.

Your industry analysis should be in-depth and to-the-point.

For example, if you are tracking the aluminium industry, you should know the per capita consumption in the country.

In India, the per capita consumption of aluminium is 1 Kg, in the USA, it is 25 to 30 Kgs, in Japan, it is 15 Kgs and in Taiwan, it is 10 Kgs.

Apart from consumption, you should also know the production of aluminium worldwide.

The above six steps are important and you, as an analyst, should follow them.

The analysts in private equity, investments banks, equity research firms, investment research firms need this skill and if you know how to do industry analysis, you are ahead of 80% of the aspirants as this will not only impress your interviewer but also add immense value to you and the business owners hiring you.

How to Write an Industry Analysis?

In the last section, we learned how to do industry analysis and in this, we will see how to write one.

Writing is also a required skill as you need to present all the findings within a written report in a concise and clear manner.

Begin by writing a concise overview of the industry.

Mention historical data and the nature of the industry, including its growth potential.

State the influencing economical factors, competitive strategy, SWOT (Strengths, Weaknesses, Opportunities, and Threats) Analysis, new competitors, business plan, competitive forces, and most importantly, don't forget to mention the purpose of your industry analysis.

The concise overview of the industry should include its competitors and its operations.

You can write this in the next section. Write about similar products and services.

Now, with the overview aside, move on to the detailed analytical presentation of the specific industry.

Highlight factors like geographical growth, consumer base, price fluctuations, past performances, and income projections.

Use existing financial data and industry understanding to forecast industry growth for the next five or ten years. You can use the statistical graph in this section.

The next sections should be about using Porter's Five Forces model, competitive advantage, and a detailed write-up about its five factors, its use, and its repercussions in the industry.

Don't forget to mention governmental regulations relevant to the industry.

Lastly, give long-term and short-term valuations impacting the industry such as any foreseeable problems impacting the business in a negative fashion and potential corrective measures.

Wind up the industry analysis report with a very three or four-line summarization.

Read this guide to know the importance of industry analysis in equity research careers.

Industry Life Cycle

Now, we will see, different stages in the industry life cycle.

There are stages in everybody's life like childhood, adult, middle age and then old age.

Likewise, there are four stages in every industry's life cycle.

If you observe the Gaming industry closely, you will find that there are many firms out there having high investment rates, high rates of return on investments and low rates of dividend payout.

The same observation can be conducted on the steel industry and you will find firms with low rates of investment, low rates of return and higher dividends payout. What could be the possible reason for this difference?

Let's find out.

In Recent times, better opportunities have been created by available technologies for substantially profitable investment of resources.

Patents safeguard new products and there are high-profit margins.

Such rewarding opportunities allure the firms in putting all profits back into the firm and the growth of firms, on average, is speedy.

However, the growth must slow down in due course of time.

Looking at the high-profit rates, more and more firms are encouraged to enter into the industry.

As a result, the competition increases affecting the prices and profit rates.

Advanced and new technologies start becoming more obvious, the extent of risks decreases making the entry easier.

The degree of reinvestment in these firms reduces as the internal opportunities become less lucrative and the cash dividends become high.

Eventually, cash cows are noticed in a mature industry.

By cash cows I mean firms having consistent cash flows, dividends, and low-risk levels.

Growth rates may be analogous to that of the overall economy.

High risk and high returns on investments are offered by industries in the initial stages of their life cycles.

On the other hand, low risk and low returns are offered by mature industries.

Thus, from the above analysis we can say that an industry life cycle can be classified into 4 stages:

Industry life cycle stages

Start-up stage in which growth is extremely fast, consolidation stage in which growth is not as fast as start-up stage but is faster than the general economy, maturity stage in which growth is not faster than the general economy and the relative decline stage in which the growth rate is less than that of the general economy.

1. Start-Up Stage

New technologies like personal computers or wireless communication portray the initial stages of an industry life cycle.

At this stage, it is very difficult to anticipate which firms will succeed; some firms will be a total success while some might fail completely.

Hence, the risk involved in selecting any specific firm in the business is quite high at this stage.

However, at this stage, since the new product has not yet flooded its market, there will be rapid growth in sales and earnings at the industry level.

Like, for example, in the 1980s, personal computers were a part of very few houses, while on the other hand, products like fans or even refrigerators were part of almost every household.

So naturally, the growth rate of products like refrigerators will be much less.

2. Consolidation Stage

Once the product has proved itself in the market, several leaders in the industry start surfacing.

The start-up stage survivors become more stable and market share can be easily envisaged.

Thus, the performance of the industry, in general, will be more minutely tracked by the performance of the firms that have survived.

As the product breaks through the market place and is used commonly, the growth rate of the industry is still faster than the rest of the economy.

3. Maturity Stage

The product has attained the full aptitude to be consumed at this stage by the users.

So, any growth from this point just tracks the growth of the economy in general.

At this stage, as the product gets more and more standardized, it compels the producers to compete heavily on a price basis.

As a result, the profit margins are lowered and add to the pressure on profits.

Most often, firms at this stage are referred to as cash cows as their cash flows are quite consistent but offer very little opportunity for growth of profit.

Instead of reinvesting the cash flows in the company, they are best milked from.

4. Relative Decline

In this stage following features are identified.

Costs become counter-optimal

Sales volume decline or stabilize

Prices, profitability diminishes

Profit becomes more a challenge of production/distribution efficiency than increased sales.

Which industries do you think will give the highest returns in the next 2-3 years?

I am sure, you are now clear about the different stages in the industry life cycle.
Want to become a sector or business specialist? Here are some courses that will help you to become a top-class industry analyst.

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How to Do Industry Analysis: The Best Guide in 2020

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In my last article, I covered how to predict the earnings of a company and today I am going to write about how to do industry analysis. Industry analysis is an essential responsibility for an equity research analyst. As an equity research analyst, you need to analyze a particular industry, see its past trends, demand-supply mechanics, and future outlook.

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Opinions expressed by Entrepreneur contributors are their own.

Besides developing an exceptional product or hiring the right talent, doing some much-needed market research is the most critical step for any startup. A part of this research should involve market size. Without knowing your market size, you may be conducting business in a market so small, it's next to impossible to make any money.

Understanding market size helps you distinguish between two categories: the addressable market, which is the total revenue opportunity for your product or service; and the available market, which is the portion of the addressable market for which you can realistically compete. By outlining the difference between these two, you can develop a product offering to tackle that consumer sweet spot.
Related: Why Entrepreneurs Must Research Market Size
Without a solid grasp on your market size, you endanger your business' success in not only the early stages, but also throughout its entire life cycle.

Seeing the business horizon.

Market sizing gives you a sense of market trends. It can clue you in on the necessary drivers of demand, as market movements often continue in one direction or another for a period of time. What's more, those trends often indicate whether a substitute for your product is on the horizon that could potentially affect market size.

Take Kodak, for example. Prior to the late '90s, almost every picture in the U.S. was developed on Kodak film. Its name was synonymous with photography. But then digital broke big, and the number of digital cameras went from 4.5 million units in 2000 to 28.3 million units in 2007.

Instead of doubling down on digital photography, Kodak steadied its course, neglecting to look at what digital meant to both the addressable and available markets. As the addressable market dwindled, so did the available market, and the company's complacency led to the downfall of its brand.

Once you understand its importance, how exactly should you go about determining your market size?

1. Define your subsegment of the market.

Not even the largest, most established company has a 100 percent share of the market. In the case of Airbnb, its first big grab came from the shortage of hotel rooms during the 2007 Democratic National Convention. Zero in on your initial pool of customers, and make sure you have a handle on this group before you expand.
Related: 9 Questions to Ask When Assessing a Market
2. Conduct top-down market sizing.

Look at the total market for your product or service, and then establish a realistic estimate for your market share. Take, for example, the hospitality industry. U.S. travelers spent $23 billion on vacation rentals in 2012 -- if Marriott International accounted for $13.8 billion of that spend, it would probably be a stretch to count the remaining $9.2 billion as yours for the taking.

3. Follow with bottom-up analysis.

Determine where you'll sell your products, how many locations will stock them and how many comparable products typically sell. Try to be as objective as possible -- it'll help you figure out where realistic growth could take you in five years. Then, compare your numbers with the overall addressable market. If it's 1 to 5 percent of the pie, you have a realistic plan.

How crowded is your industry, and what types of companies are at the forefront? If, for instance, you were the only steel producer for a specific type of product, it'd be reasonable for you to get to a 50 percent market share. As a new airline in the travel industry, on the other hand, the likelihood of getting even a 10 percent market share is slim.
Related: 8 Strategies for Expanding a Niche Product Into New Markets
5. Assess the static market size.

Doing business in a static market comes with fierce competition. You and your competitors vie for the same pool of customers every year. Looking at hospitality again, a new hotel company must determine if the budget segment is growing faster than the luxury segment. This will inform how the long-term total addressable market size will likely change, which can help you respond to trends.

Being realistic about your projections is really the most important aspect of determining market size. That means staying objective and impartial about not just your product or service, but also about consumer need and want. Otherwise, you could find yourself doing business in a market too small to stay afloat.

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5 Strategies to Effectively Determine Your Market Size

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Opinions expressed by Entrepreneur contributors are their own. Besides developing an exceptional product or hiring the right talent, doing some much-needed market research is the most critical step for any startup. A part of this research should involve market size.

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For most businesses, the concept of market sizing is readily understood but not easily accomplished. Many get stuck on establishing boundaries or defining the market before they even get to the data analysis and implications of their research. Determining market size can answer strategic questions about levels of investments in the business and profitable growth targets. Market sizing can also serve as a quick understanding of the potential for a B2B market opportunity in terms of volume or value, and is therefore pertinent to business strategy and decision making.

Below are the 5 basic steps in estimating market size.

1. Defining the Market

Knowing the level of detail necessary to approach your strategic questions is the key to properly scoping your market sizing approach. Defining your target market should always be the first step in estimating market size, and it is critical that you do not stray from your determined market definition through the data collection process.

Market size can be viewed in terms of Total Available Market (TAM), Served Available Market (SAM), and Share of Market (SOM). Total Available Market refers to the combined revenue or unit volume in a specified market. Often a company or investor will require the market size or Total Available Market for a particular geographic area. If we take the example of food packaging, the Total Available Market can be calculated by adding sales of food packaging producers in a particular geographic region or market segment.

The Served Available Market refers to the percentage or size of TAM that a company can reasonably serve based on product, technology and geographic constraints. SAM typically will be less than TAM. Using the same example of food packaging, if the TAM for food packaging is $200 BN, then the Served Available Market for companies making flexible packaging would be only a percentage of TAM. Lastly, Share of Market or SOM refers to the percentage of SAM that a particular company currently serves or plans to serve. Again, SOM should be less than SAM except in the case of a monopoly.

In your market sizing process, start by determining what products or services should be included as part of your TAM. Then narrow down by geographic scope-US, North America, Europe, etc. Another factor to consider is the timeframe. Are you looking for historic market sizing or future projections? By defining what should be included in your market sizing estimation, your company can more accurately determine the market potential and the estimated available share of the market.

2. Determining Your Approach

There are two basic methodologies for determining market size: top-down and bottom-up. Your selected approach may be based on what market information is available. However, the best approach is to develop market sizing estimations using both methodologies in order to gain a higher confidence in your estimation.

The top-down methodology uses a broad market size figure and determines the percentage that the target market represents. For example, to determine the TAM for food packaging, you might start with retail sales of packaged food and multiply by an assumed packaging cost (e.g. 10% of the total retail food value is packaging cost). In general, a top-down approach is typically a quicker, more time efficient approach. It is great for validation or a quick assessment of market size but seldom will provide the detail necessary for a true opportunity analysis.

The bottom-up methodology builds the TAM by totaling the main variables of the target market. Using the same example of food packaging, a researcher might total the food packaging sales of packaging producers - all food packaging or by package type or by geography. This method is generally considered to be more accurate and takes considerably more time to complete. As a result, the bottom-up method is a more valid estimate because it is less likely to include non-addressable revenue or units.

3. Selecting Sources

Your selected approach will dictate the necessary sources to estimate market size. Secondary research or desk research searches for existing data and is the most commonly used form of research in this type of exercise because it is quicker to obtain and therefore usually more cost effective. Through general web searching, a wealth of information can be found at little or no cost. Subscription-based or syndicated research is a great place to start, but there are also free sources that contain valuable information. Articles about companies or products in the target market will often quote data from these sources. You might also check whitepapers and product announcements for similar information. Publicly held companies are required to share information in analyst and investor reports. Quarterly and annual reports are typically available on these company websites as well as through the SEC filings. Also, trade associations will often conduct market research and aggregate industry data.

Primary research, also called field research, is often used in addition to secondary research. The primary research can take on many forms and can strengthen your understanding of the market, allowing you to make better informed assumptions. The most versatile form of primary research is in-depth telephone interviews that can be used to capture more sensitive information. If possible, on-site visits can be used to confirm or contradict market sizing estimations or determine key information on market trends, such as technology, market performance, relative competitive position or other information dealing with understanding scope and defining the target market.

4. Data Structuring-Typology

To further develop your understanding of the market, it is important to gather trend information, which is typically in the form of qualitative data. This information can come through secondary research or comments from primary research. If we look at food packaging, it may be of interest to evaluate trends for specific food segments, such as dairy, meats/poultry/fish, or beverages. For example, look for trends in beef packaging that differ from chicken or pork. It may also be valuable to look for trends in packaging type (cans, cartons, trays, etc.) or fill technology (hot fill, aseptic, ESL, etc.).

Once the trends information has been collected, you can start structuring data by group or theme. Typology is the strategy for qualitative data analysis to group findings into distinct categories in order to identify data themes.

This process allows the researcher to quickly consider the value of information by comparing with other information in the same "cluster" or "line." Typology is also useful for creating a story line as the project moves into analysis stage and the development of conclusions.

5. Data Analysis

As mentioned above, it is often necessary to develop multiple estimates using different approaches or sources. This is called triangulation. When multiple sources or estimations triangulate, the confidence in a market estimate increases. If the approaches widely differ, additional research is required to reduce risk and is recommended to narrow the range of market sizing estimates.

Common pitfalls or mistakes often start early on by not properly defining the market or gathering data from non-reputable sources. The market definition should remain consistent throughout the data collection process and methodology should be based on market knowledge-not just demographics. Where possible, attempt to verify each significant finding through multiple published source materials or primary research. By confirming findings, you are able to leverage the value of various information sources and thus increase confidence in the final results.

Download our free white paper for more information on the benefits of market research and how to use market research to better understand your industry.
Editor's Note: This post was written by Priority Metrics Group (PMG), a MarketResearch.com partner in custom research. About PMG:
Priority Metrics Group (PMG) is a professional marketing consulting firm based in Spartanburg, South Carolina. PMG provides customized research, analysis, and consultation services designed to generate profitable growth for clients. They work with leading organizations in a variety of manufacturing and service industries. They are experts at gathering and processing market information, analyzing data, and translating information into actionable growth initiatives.

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For most businesses, the concept of market sizing is readily understood but not easily accomplished. Many get stuck on establishing boundaries or defining the market before they even get to the data analysis and implications of their research. Determining market size can answer strategic questions about levels of investments in the business and profitable growth targets.

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IBISWorld - Industry Market Research, Reports, and Statistics

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Find the most up-to-date industry trends, top 10 lists and industry information to help you create better sales and marketing strategy plans, know what markets to enter or avoid, and to guide a variety of business decisions. IBISWorld is a leader in global industry research and we're known for our breadth and depth of trusted data and analysis.

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One of the most crucial tasks an entrepreneur has is to calculate the size of their market, and the potential value that market has for their startup business. Without this data you can't create a viable business plan, or be taken seriously when approaching potential investors.

As described in my book, The Art of Startup Fundraising, the market needs to be in the billions. Otherwise, even if you have the perfect team and product the returns will be limited for potential investors making your investment opportunity less attractive.
Market Size for Startups
Determining the market size is critical. It tells you and your partners, team and investors how much potential business is really out there. It helps calculate how much value there really is for your individual venture. This is critical to know, even if you never plan to raise a dime in outside capital.

Market size becomes far more important if you ever need to raise funding for your business. It is one of the most basic digits every potential angel and VC investor is going to expect. Even your friends and family should be asking about it during seed and pre-seed financing rounds. Coming up empty handed is going to destroy your credibility instantly.

Unfortunately, this is one factor which entrepreneurs frequently blow when formulating initial plans, stepping out into a new business and when pitching investors. So, how do you do it right?
How to Determine Market Size
To calculate your market size, you'll either be looking for data on the number of potential customer, or number of transactions each year.

For example; if you are selling toothbrushes, virtually everyone can be counted in your big whole market figure. If people are listening to their dentists, and they are purchasing new toothbrushes 2-4 times per year, that number is even larger. If you are selling houses, then there may only be an average of 5.34M transactions in a good year, in the entire United States.

Keep in mind:

Show projections going out 3 years (it's hard to accurately analyze after that)

Account for organic growth or decline in the years ahead

Your roll out to geographic areas over time

There are a variety of ways to acquire this data. Census and labor bureau hold a lot of information, and most industries have formal associations which compile and track this type of data. You can also commission your own research or purchase studies.

Once you have the data you want to make sure that you are presenting it in a powerful way in your pitch deck since it is one of the most important slides. A good pitch deck template is the one created by Silicon Valley legend, Peter Thiel ( see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash. Thiel actually includes not one, but two slides around the market and its size. Moreover, I also provided a commentary on a pitch deck from an Uber competitor that has raised over $400M ( see it here).

Below is another example of how to show in your pitch deck your market growing over time.
How to Determine Market Value
Market size, or the number of potential customers or unit sales is one thing. How much that is worth, is a completely different, and perhaps more important figure.

You need to know how much revenue that market has to offer. For example; UpNest is one of the fastest growing real estate tech startups, which helps home buyers and sellers save on Realtor commissions. If the average home price is $394,300, and there are 5M sales per year, and the average Realtor commission is 5% of the sales price, and 90% of users use a Realtor, UpNest is in an $88.7B per year industry. Or has a market size of $88.7B.
Determining Total Addressable Market (TAM)
Realistically, no startup should or can expect to gain 100% market share. Trying to capture an entire market, without first targeting several niches, price points, customer sizes or geo areas for roll out, is going to be financial suicide for the vast majority of entrepreneurs.

For example; even giant online real estate firm Zillow, which dominates the marketplace, has far more modest estimates for its own new venture in buying and flipping houses directly with consumers. The company's CEO recently said that if it could acquire 275,000 units a $3,500 profit each, it would be doing very well. That's about $1B a year from just one extra revenue stream, at just over 18% of the available market share.

Of course, most new startups can't expect to even command that much market share. Even if you could, most seasoned investors won't believe it until you prove it. of Karlin Ventures says "If it's 1 to 5 percent of the pie, you have a realistic plan."

If you have no idea what's a reasonable amount of market share in your industry, Projection Hub says one hack is to anonymously call around to all of your local competitors and find out how much volume they are doing. Then estimate you'll be doing a fraction of that as you gain traction.

Also factor in the static versus evolving marketplace. Do population growth rates mean there will be more prospective customers in your market in 5 years, or less? Don't forget to factor in your own impact on the market.

For example; if you were Amazon a decade ago, you should have factored in the fact that you are about to destroy the marketplace for regular bookstores. Their price cutting also slashed the value of the market in a huge way.

Early stage startup investor at Matrix Partners, Jared Sleeper notes there are actually :three distinct ways to calculate TAM."

They are:

1. Top-down, using industry research and reports.

2. Bottom-up, using data from early selling efforts.

3. Value theory, using conjecture about buyer willingness to pay.

It's best to know them all before you go into an investor meeting, or finish polishing your pitch deck.
Summary
Knowing your market size is a basic foundational part of launching any startup venture. Every entrepreneur needs to know how to calculate it, and how it relates to potential revenue in their addressable market.

Be realistic. Investors like big numbers, but don't have patience for flakes over-inflating numbers. You should be able to show the potential to achieve VC sized growth and returns over time. Just make sure you can back up your claims with the data and research, you derived your numbers from, and how you arrived at your assumptions.

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How To Effectively Determine Your Market Size

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One of the most crucial tasks an entrepreneur has is to calculate the size of their market, and the potential value that market has for their startup business. Without this data you can't create a viable business plan, or be taken seriously when approaching potential investors.

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Learn how many customers your start up business is likely to reach by calculating market size, and the total addressable market.

Market research is a vital part of any new business process. Just as important as hiring the right staff or finding the best premises, market research allows you to learn more about your potential customers and gives your new business the best chance for success.

Central to any market research you conduct is calculating market size. Learning how to calculate market size is important: too small a market could mean there aren't enough customers, and your business might not make enough money to be profitable. Calculating market size also helps you think about how much of that market you could capture - called market share - and how much of a market your business needs to prosper.

What is market size?

At the most basic level, market size is simply the number of potential customers that you could sell your product or service to. For example, it could be the number of people who visit a high street who could become customers of a new coffee shop, or it could be the number of dog owners in your local area that could use a dog grooming service.

There are two types of market size to calculate along with your business' expected share:

Total addressable market - this is shorthand for checking if the potential market for your start up is big enough, and is usually the first type of market size to calculate. Shortened to TAM in business circles, it is the number of customers or amount of money you could earn if you were 100% successful and achieved 100% sales to every potential customer.

Target or available market - this is the market size that your start up business can realistically reach. It's a subset of the total addressable market, and is sometimes referred to as the Segmented Addressable Market (SAM).

Expected share of market - this is a useful addition to the two market size calculations above. It's an extra stage that helps you learn what share of the market you want to aim for, and what you expect your business to achieve. This is often referred to as the Expected Share of the Addressable Market (ESAM), or simply market share.

Watch this: Understanding markets can be complex, but in this video from Tutor2u Graham Prior explains the key concepts in calculating and interpreting market size, growth and market share:

What to look out for when calculating market size

Before starting to calculate, it's worth understanding that calculating market size means being objective about the facts: it is not about interpreting market information to support your business case. If the market size data reveals problems, such as lack of local customers, it's a red flag that means it may not be profitable to launch your business in that location, for example.

Markets aren't static - they develop and change - and you'll need to factor in market trends, such as new technologies or consumer buying habits. Calculating market size relies on assumptions but it will help you think about market trends and their impact on your new business.

Market trend example: The video tape rental business Blockbuster was once ubiquitous on high streets across the UK. Yet it failed to anticipate the technology trend of online movie streaming, which helped launch companies such as Netflix. The result is Blockbuster lost huge market share until it closed, as Netflix increasingly won movie-watching customers.

Make sure to monitor market trends and think about how they could impact your business, even once you've migrated from start up to an established business. Taking advantage of new market trends can give your business an edge over competitors.

How to calculate market size

Calculating market size means you should follow the process of calculating the addressable market, then the available or target market, and finally work out how much market share your business will generate. Here's how to calculate market size for each stage:

1. How to calculate the total addressable market

The total addressable market is simply all the potential customers who could be in the market for the products or services your start up is offering. It's very broad. For example, if your business specialised in online learning and tutoring for school students, your total addressable market would be all UK students who have access to the internet and have parents or guardians willing to pay for tutoring.

Define your customer - set a few characteristics about the customers in your market. In our example, this could be students or parents concerned about exams, willing to pay for tutoring, and have home internet. Use this to define the market.

Conduct desk research using the internet - look for available data from sources such as the Office of National Statistics (ONS), government whitepapers, company or industry reports, and online research. The aim is to gather facts about the size of the defined market, such as the number of students in the UK, how many homes with students have internet access, and any information about the percentage of students who have tutors.

Carry out some top down analysis - this puts some numbers into your market size calculation. For example, you might discover there are around 650,000 UK students who take GCSEs each year, and 95% have online access with 30% of those paying for tutoring. That would give you a total addressable market of 185,250 GCSE students who could buy an online tutoring service. While sketchy, you could then assume that if your business attracted 5% of students to your online tutoring business, you would have around 9,250 customers each year.

Calculating the total addressable market allows you to see if there are enough customers for your start up to be worthwhile.

Watch this: Get additional help with this video from Entrepreneur, which provides ten useful tips on how to get to know your target market better:

2. How to calculate the segmented addressable market

While calculating the total addressable market size is useful, you really need to zoom in on the number of customers your business can realistically reach. Target customers are the customers who might consider using your business, that your marketing can reach, and that other factors such as competitors can influence.

One way to calculate the segmented addressable market is by using bottom up analysis. This is about counting potential customers you can reach based on speaking to experts in the market, surveying customers, and refining the information you used to calculate the total addressable market. It looks at sales of competing products, how you'll distribute them, and how many customers you could target. Let's work through an example.

1. Let's assume you want to get a share of all 185,000 GCSE students who get private tutoring in the UK. The question is how to reach them, so let's start with schools.

2. You could develop a tutoring sample pack to be sent to schools, but how many will stock it? Carry out some research by surveying, say, 100 schools. If half say they will hand it out to students, then cut that in half again to be safe - meaning around 25% of schools would do as they have said pass out your sample pack.

3. There are 3,268 secondary schools in the UK, so we can assume that 817 (25%) will pass out your sample pack. Each school has around 60 GCSE students paying for tutoring, so you could reach 49,000 potential student customers.

4. Survey some potential students who fit your customer profile. How many would be interested in online tutoring? How much would parents be willing to pay? Let's assume that around 10% would be interested in online tutoring for the right price. That means you have a target market of 4,900 students from this marketing approach.

5. You might want to consider other marketing channels as well, such as using social media or advertising on websites used by students or parents looking for online tutoring. Estimate how many potential customers would see your online marketing, and use industry standard conversion assumptions to calculate how many will respond.

It's worth being ruthless when calculating your target market size. Remove all the customers that you will never reach, such as those who are very rich or too poor to have disposable income to spend on your business, or who don't use the internet if selling online.

Build in sensitivities as well. These are honest reflections on how well your marketing will realistically do, how long it would take you to contact customers, and how quickly new customers will respond to your marketing activity. Use these to refine your market size calculation.

3. How to calculate market share

Unless your start up business is entirely unique, chances are you'll have competitors who are also chasing the same customers. Taken together, the total number of customers who buy from all competitors in the market is also a useful indicator of the target market size.

Market size example: You discover that there are already 20 online tutoring businesses operating in the UK. By researching them, you estimate that together these have 90,000 students paying for online tutoring each month. You can use this as your target market.

Look at the target market, then estimate a sensible market share. This should include looking at competitors, their offerings and routes to market. You should aim for around 1% to 5% as a realistic goal over the first few years as a start up, unless you're first to market with a new product or there are few or no existing competitors in your market.

Investigate competitors - Find out who is supplying the market and their turnover. Visit Companies House online and look at annual returns, as well as trade press and any press releases about significant customer wins. You can also look at annual reports to estimate numbers of customers and how much spending. From this, build up a picture of the rough market share for each of your competitors.

Market share example: If there are 90,000 students paying for online tutoring between 20 companies, then each company would have around 5% share. Naturally, some companies may have more - say 10,000 students or 9% share of the market. Look at each competitor and decide if your product will be more attractive, and who you want to take market share from.

Be realistic - Most start ups won't get 1% market share in the first year, and perhaps 2% in year two if fortunate. Many companies never achieve more than 10%-20% of target market share.

Plan your business - What market share do you need to break even and start making money? Do the maths, working out how much revenue you'll likely make in each year.

Market share example: In year one of our example, your online tutoring business will aim for around 0.5% of market share, which is around 450 students. If the average monthly fee for online tutoring is £10, then your business would earn £4,500 per month or £54,000 in one year. If you aim to target 2% market share by the third year, your business would be generating £216,000 in revenue.

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How to calculate market size | Start Up Loans

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Market research is a vital part of any new business process. Just as important as hiring the right staff or finding the best premises, market research allows you to learn more about your potential customers and gives your new business the best chance for success.